These Taxing Times

As this is being written, the House and Senate are considering compromise economic stimulus legislation. The result may be available later this week. While I have been monitoring the separate bills as they have progressed through Congress, I have not cluttered your inbox with the proposals. As soon as a compromise bill is sent to the president, I will begin reporting its significant tax provisions and tax planning opportunities to you.

In the meantime, the Internal Revenue Service recently called attention to the Treasury’s recently updated Report of Foreign Bank and Financial Accounts (FBAR). I wanted to share this with you, because failure to file this report can have serious consequences.

All of the major tax returns (individual, corporation, partnership, trust and estate) or their attached schedules ask, “At any time during the year, did you (or the corporation, partnership, trust or estate) have an interest in or a signature or other authority over a financial account in a foreign country, such as a bank account, securities account, or other financial account?” Many taxpayers simply check “Yes” and answer a question reporting the country or countries in which the accounts are held. The reporting requirement, however, does not end there. If the answer is yes, the taxpayer is required to separately file Form TD F 90-22.1 (Report of Foreign Bank and Financial Accounts). The FBAR is not attached to the tax return and is typically not prepared as part of the regular tax return preparation process.

Any United States person who has a financial interest in or signature authority, or other authority over any financial account in a foreign country, is required to file if the aggregate value of these accounts exceeds $10,000 at any time during the calendar year.

A FBAR is filed by June 30 of the year following the year that the account holder meets the $10,000 threshold with the U.S. Department of the Treasury, P.O. Box 32621, Detroit, MI 48232-0621. An extension of time to file Federal income tax returns does not extend the due date for filing an FBAR. There is no extension available for filing this form. A FBAR must be filed whether or not the foreign account generates any income.

Penalties for failure to file may be severe. A “non-willful” failure to file may result in a civil penalty up to $10,000 for each negligent violation. An additional civil penalty of up to $50,000 for each negligent violation may be assessed if there is a pattern of negligent activity. Willful failure to file FBARs or to retain records of the accounts may result in a civil penalty of the greater of $100,000 or 50 percent of the value of the account, and criminal penalties of $250,000, a 5-year prison term, or both. OUCH!

If you learn you were required to file FBARs for earlier years, you should file the delinquent FBAR reports and attach a statement explaining why the reports are filed late. The Service will assess no penalty if it determines that the late filings were due to reasonable cause.

As with any other aspect of tax law, definition of terms is important. I haven’t attempted to define terms in this short communication, but if you have any questions concerning FBARs, contact me at 214.957.3366 or email me.

Ronnie

Copyright 2009 Ronnie C. McClure, PhD, CPA

The Internal Revenue Service recently issued a fact sheet regarding shareholder-employee compensation from an S corporation. Tax advisors commonly advise S corporation shareholder-employees to pay themselves minimum compensation in the form of “wages” subject to Social Security and Medicare taxes, and take the rest of their compensation as “distributions” not subject to federal employment taxes. Remember, too, that the term “wages” includes all remuneration for employment, such as the cash value of all benefits. The fact sheet cautions that, “S corporations should not attempt to avoid paying employment taxes by having their officers treat their compensation as cash distributions, payments of personal expenses, and/or loans rather than as wages.” This is an area of serious contention between the Service and S corporation shareholders and their attorneys.

Generally, shareholder is an employee of a corporation if he or she performs more than nominal services for the corporation. The Treasury Regulations provide an exception for an officer of a corporation who does not perform any services or performs only minor services and who neither receives nor is entitled to receive, directly or indirectly, any remuneration. Such an individual would not be considered an employee.

Instructions to the Form 1120S (U.S. Income Tax Return for an S Corporation), state, “Distributions and other payments by an S corporation to a corporate officer must be treated as wages to the extent the amounts are ‘reasonable compensation’ for services rendered to the corporation.” The obvious issue is, “What is reasonable compensation for a shareholder-employee?” Neither the Internal Revenue Code nor the Treasury regulations define the term. Various courts have defined “reasonable compensation” based on the facts and circumstances of each case, based on some of the facts below:

• Training and experience
• Duties and responsibilities
• Time and effort devoted to the business
• Dividend history
• Payments to non-shareholder employees
• Timing and manner of paying bonuses to key people
• What comparable businesses pay for similar services
• Compensation agreements
• The use of a formula to determine compensation

Under current law, wages of less than $106,800 coupled with high distributions will certainly raise “reasonable comp” questions with the Service. That amount is the FICA limit in 2009 subject to the 12.4 social security tax; amounts above that are only subject to the 2.9 percent health insurance tax. This amount should not be considered a “safe harbor,” however.

The fact sheet also addressed treatment of medical insurance premiums paid on behalf of (or reimbursed to) shareholder/employees. It states that “The health and accident insurance premiums paid on behalf of the greater than 2 percent S corporation shareholder-employee are deductible by the S corporation as fringe benefits and are reportable as wages for income tax withholding purposes on the shareholder-employee’s Form W-2. They are not subject to Social Security, Medicare, or Unemployment taxes. Therefore, this additional compensation is included in Box 1 (Wages) of the Form W-2, Wage and Tax Statement, issued to the shareholder, but would not be included in Boxes 3 or 5 of Form W-2. Payments of the health and accident insurance premiums on behalf of the shareholder may be further identified in Box 14 (Other) of the Form W-2.”

All of this may change, however. There is some thought of making S corporation “distributions” subject to self-employment taxes in the same manner as a partnership. While that may cure the problem, the barrier to such legislation is the fact that corporations (including S corporations) are legal entities separate from their owners. I’ll be watching for developments in this area as tax legislation emerges from a new Congress.

If you have questions concerning tax treatment of compensation to owners of S corporations, partnerships, or LLCs, call me at 214.957.3366 or email me.

Ronnie

Copyright 2008 Ronnie C. McClure, PhD, CPA

The votes are in; the Democrats will control the White House and both Houses of Congress. Federal taxes will increase. In my opinion, federal taxes would have increased no matter which party won the presidential election; the issues are now; “How much?” and “Whose ox will be gored?” If the new Administration and Congress are going to demonstrate any degree of fiscal responsibility, they must address the massive deficit in which this nation finds itself and the ability to pay for the new programs we have been promised.

From a tax perspective, I believe everything is on the table; income, transfer, employment, and excise taxes. Notwithstanding the campaign rhetoric, I believe that every income tax bracket is at risk with the highest rate probably being 39.6 percent, the long-term capital gain rate at least 20 percent and possibly twenty-five, the highest estate, gift, and generation-skipping transfer tax rates will not be below 45 percent, and the estate tax exemption will not exceed $3.5 million per person. Corporate tax rates will not go down. Count on a tax bill passing by mid-2009 with an effective date retroactive to January 1. There is little we can do to avoid the employment and excise tax increases, some of which are already on the books, so what can we do in the remaining two months to mitigate the coming income tax increase?

While all year-end tax planning must have at least a two-year focus, it is reasonable to assume that for most of us, tax rates in 2009 will be higher than those we enjoy now. Therefore, I believe it will be prudent to accelerate income into 2008 to the extent possible and postpone deductions until 2009. The higher your income tax bracket, the more important this becomes. I believe that the rate change is particularly important for capital gains.

Keep in mind that a change in the capital gains tax rate from 15% to 20% is not a five-percent increase, but an increase of 33-1/3 percent. Likewise, an increase from 15% to 25% would be an increase of 66-2/3 percent. An increase in the highest ordinary income tax rate from 35% to 39.6% is an increase of more than 13%, not the nominal 4.9%.

The rule of thumb would be to defer taxes until a later year because of the time value of money. Assume you could trigger a $10,000 capital gain in either 2008 or 2009 and the capital gins tax rate was not increasing from 15%. It would be better to defer the $1,500 tax until next year, invest that amount at a 5% return, cash in the investment a year from now, pay $1,500 tax at that time, and keep the $76 interest income. If you assume a long-term capital gains tax increase from 15% to 20%, however, the economics change.  You would have to invest about $1,900 today to pay a $2,000 tax a year from now on the same $10,000 gain. Alternatively, you could recognize the gain this year, pay the $1,500 tax now and be better off by $400. If you assume a tax increase from 15% to 25%, the numbers change even more dramatically. You would have to invest about $2,380 today to pay a $2,500 tax a year from now. Alternatively, you recognize the gain this year, pay the $1,500 now and be better off by $880.

It seems to me that appropriate year-end tax planning would involve accelerating all income and gains this year and deferring losses and tax deductions until next year, unless you know you’re going to be in a much lower tax bracket in 2009. So how do you do that?

• Recognize capital gains and qualified dividends this year, and defer losses until next year. I don’t believe there’s a significant chance the losses will go away between now and January.
• If you already have net capital losses this year, no harm no foul; they will carry over to future years and offset higher taxed gains in future years. (If you choose to trigger capital losses during the remainder of the year, wait at least 31 days before re-investing in the same securities).
• Cash-basis businesses should bill customers and clients early and push for collections in 2008. Keep in mind, however, that your cash-basis customers and clients will likely want to wait and pay you in 2009.
• To the extent possible, take commissions and bonuses in 2008.
• Defer tax-deductible items (property taxes, mortgage interest) until next year.
• Charitable contributions are a special consideration. If you are gifting cash, do so January 2, 2009 rather than December 31 of this year (don’t harm your charitable beneficiaries by waiting longer; they need the gifts more now than ever before). If you are giving appreciated property, do so in January. If you are going to sell securities that have declined in value, wait until January, sell the stock, recognize the loss, and gift the cash.
• If you are age 70-1/2 or older, own IRAs, and want to make a charitable contribution from your IRA, have the IRA trustee make the gift this year and have the distribution made payable directly to the charity, not to you.
• If you plan to make energy saving improvements to your home, postpone them until 2009. A $500 tax credit may be available.
• Business deductions for equipment purchases may be more beneficial if taken in 2008, not 2009. In 2008, you may elect to expense up to $250,000 in new equipment purchases. This amount is currently scheduled to drop to $133,000 in 2009. Don’t hold me to that, however; another tax stimulus package could extend the $250,000 deduction beyond 2008.

This is the best advice I can give at this time. My “recreational reading” in 2009 will be the proposed tax law changes. I have done so since 1976, beginning with proposed legislation when it is first introduced and following it through to final legislation. I will keep you appropriately informed.

If you need help with your year-end tax planning, contact me.

Ronnie

Copyright 2008 Ronnie C. McClure, PhD, CPA

Two important reminders for you this evening. Tomorrow, Tuesday, November 4 is election day, at long last. Your vote is extremely important, no matter which candidates you choose. Just please participate in the cornerstone of our democracy and VOTE!

The second reminder is the IRS’s live, free, webcast program “preparing for the New Form 990.” That’s the annual report each charitable organization must file with the Internal Revenue Service. The one-hour program begins at 2:00 pm EST (1:00 CST). Program details are below:

CPE Program Level: Overview
1 CPE Credit Recommended; NO prerequisites or advance preparation CTEC Course #: 3022-CE-0059 ELMS Course #: 22891

Program Content:
It’s been 30 years since the IRS made major changes to Form 990 and when many tax-exempt organizations file their 2008 tax year returns, they will confront a radically redesigned form. Because the revised Form 990 is so different from previous years’, IRS and tax-exempt sector experts will discuss the redesigned 990; make sure you know what parts of the forms to complete and answer your questions to help you become familiar with and prepare for the changes now.

Learning Objectives:
The primary learning objective is to maintain or increase competency of tax practitioners through expert discussion, explanation and interactive questioning. The programs are designed for learners (tax professionals) to exercise a practical understanding of new and current tax policies, as well as the latest changes, in a complex and continually changing industry. a complex and continually changing industry.

Form 990 has changed significantly for calendar year 2008. Make sure you know how it will impact your organization.

Ronnie

Copyright 2008 Ronnie C. McClure, PhD, CPA